Federal Reserve & Interest Rates

The underlying reason why commodities have retreated in the past month is that the dollar has experienced a resurgence in currency markets.  Currency experts feel that the dollar is ready for a period of renewed strength after years of bearish sentiment.

Weakness in foreign economies has increased demand in the greenback as it is looking like the European Union is in the midst of a recession.  Recent data showed that the EU economy actually contracted last quarter.

Taken with the fact that earlier this week the Commerce Department revised GDP upwards for the second quarter the Fed is more likely to raise interest rates before the European Central Bank(ECB) will.  The ECB has maintained it’s strict stance on price stability but many analysts feel it will eventually have to reverse it’s course from last month, after it raised rates by a quarter percent.

There could well be a strengthening synergy effect between the dollar and oil.  As the dollar gains and oil falls it lowers inflationary pressure across the globe and will take some of the pressure off the ECB to maintain higher interest rates and could give them some leeway to deal with contracting economic growth.

However, the same case could be made for the Fed, there is much less pressure on them to raise rates than there was two months ago and the Fed Chairman feels inflation will continue to moderate into 2009.  The Fed is still concerned with troubled financial markets but the upsurge in GDP is definitely a welcome sign.

If the dollar does go on a sustained run it could be rough times ahead for exporters and the foreign growth potential of multinational corporations particularly the tech sector.  Trade and tech have been a some of the few bright spots during this long economic slowdown.

The Federal Deposit Insurance Corp. stated that it’s list of troubled banks grew by 30% to 117 in the second quarter.

Regulators are adding to the list as bank assets, liquidity and other fiscal measures weaken. Nine banks have failed this year, including California-based mortgage lender IndyMac Bancorp Inc., which the FDIC is running as a successor institution, IndyMac Federal Bank FSB.

It’s a difficult time for the banking sector, lower earnings and difficulties in raising capital are the primary concerns.  The disintegration of the mortgage securitization market has  put a major crimp in the originate to distribute business model.

Troubled banks are having to offer high interest rates on certificates of deposit(CD) in order to attract new capital.  Just a few months before the FDIC took control of IndyMac, it had one of the highest CD rates in the country.

Many experts feel the banking sector needs to consolidate but with the investment firms having their own problems it will probably continue to be slow on the merger’s and acquisitions front.  One thing currently in their favor is that the yield curve is relatively steep at the moment but in order to take advantage of that they need to start lending.

The Fed has tried it’s best to inject liquidity into the system but banks haven’t followed through.  Like other firms in the financial services sector they have been forced to hoard capital in order to deal with writedowns while at the same time attempt to de-leverage their balance sheets.

They do have a little more time to get their houses in order.  With the commodities market retreating and inflationary pressures losing some of it’s steam, it’s unlikely that the Fed will raise rates until sometime next year.

Although a government report showed that housing sales grew by 3.1% in July, Housing and Urban Development Secretary Steve Preston says that a housing recovery is unlikely until 2009 at the earliest.  Sales may have grown but so has inventory as banks have had to take over an increasing number of foreclosed properties.

A slowdown in home sales and a drop in prices has contributed to record foreclosures as borrowers struggle to meet their monthly mortgage payments. Preston said a foreclosure- prevention law Congress passed last month also will be important in aiding mortgage-finance companies Fannie Mae and Freddie Mac, which are supporting most new mortgages.

The fate of Fannie Mae and Freddie Mac is still looming over the entire mortgage market.  Their stock has been hammered in recent weeks as equity holders grow increasingly worried that their entire stakes could get wiped out if the rescue plan becomes necessary.

There is still investor demand for their debt as Freddie Mac sold $2 billion in short term debt earlier today.  However it’s becoming increasingly expensive to raise capital as investors are requiring higher spreads over Treasury Securities of similar maturity.

The government wants to avoid a bailout of the two Government Sponsored Entities(GSE) if at all possible, but most experts feel mortgage markets would be helped more if the two companies were recapitalized with taxpayer dollars.  The two GSE’s account for nearly half of the $6 trillion mortgage market and with a housing recovery a long way off, their fortunes aren’t expected to improve anytime soon.

Even if prospective buyers wanted to purchase a home it’s difficult to find the financing, even if they have good credit scores.  The credit situation has grown steadily worse as mortgage rates keep climbing, which isn’t conducive to any sort of recovery.